Melanie Cao

Does policy uncertainty affect productivity? Policy uncertainty creates delays as firms await new information about prices, costs, and other market conditions before committing resources. Such delays can have real consequences on firms’ productivity and corporate decisions. First, we find that economic policy uncertainty has a negative impact on firm-level productivity. Second, policy uncertainty is positively related to cash holdings, but this effect is mostly driven by highly productive firms and by firms with higher levels of irreversible investments since these firms face higher opportunity costs in future states. Third, debt magnifies the adverse effects of policy uncertainty on productivity, but access to external financing during periods of significant policy uncertainty shocks has a positive impact on firm- level productivity. The three findings are robust to various specifications and provide an affirmative answer to the opening question.

Capital reallocation is procyclical and an economic boom has a cleansing effect by shifting the distribution of firms from low quality to high quality. We explain these facts by modeling search frictions for used capital in the business cycle. The article characterizes the stochastic equilibrium analytically to prove that the liquidity and the price of reallocated capital are procyclical endogenously. We calibrate the model and construct proxies in the data for the unemployment rate of capital and the time on the market. These two variables have a strong positive relationship in both the model and the data.

We propose an equilibrium valuation model for bitcoin options by extending Cao. Bitcoin is interpreted as a foreign currency in a small open economy where money supply and aggregate dividend are exogenous. The equilibrium bitcoin prices increase with diffusive and jump risks of these two exogenous factors. Analytical option pricing formulas are obtained with Merton’s model as a special case. Static analysis reveals that a bitcoin call (put) option value increases (decreases) with the money supply growth rate. Numerical analysis shows that all risks lead to a positive premium in option prices relative to the Black–Scholes model.

This paper studies liquidity and volatility commonality in the Canadian stock market. We show that five various liquidity measures display strong evidence of commonality at both market-wide and industry specific levels. Our findings extend the results of previous studies in liquidity commonality, and show that even after controlling for individual determinants of liquidity such as price, volume, and volatility, liquidity commonality remains. In addition to demonstrating liquidity commonality, we also investigated the causal relationship between liquidity and volatility. Our evidence indicates that depth, proportional effective spread, and liquidity changes predict volatility changes for bid-ask spread, depth, and proportional effective spread.

The existing economic theories on managerial compensation renders the relative performance evaluation (RPE) as the desirable mechanism to reward CEOs. However, in reality, very few firms use the RPE scheme, which constitutes a puzzle as noted by Murphy (1999) and others. This paper sheds some light on this puzzle. I show that the RPE scheme is not always the desirable mechanism in a competitive market with multiple firms and multiple agents. In other words, the apparent desirability of the RPE mechanism is a result of simplistic model setup. Once realistic features are built into the model, the equilibrium could be compatible with either an absolute performance evaluation scheme (APE) or an RPE scheme. Therefore, that the preponderance of firms use APE is not necessarily a puzzle at all. I reach the above conclusion via an equilibrium model within which the optimal incentive contract is derived in a market with many firms and many CEOs. The main innovative features absent in the existing models include the inter-firm interactions through the CEOs’ endogenized reservation utilities and the possibility for CEOs to quit. In this rich setting, I show that either form of the compensation scheme can prevail depending on the economic condition. As a by-product of the inquiry, I also show that a mixture of APE and RPE can actually better motivate the CEO and therefore enhance the firm’s profit than either of the simple form.

We integrate an agency problem into search theory to study executive compensation in a market equilibrium. A CEO can choose to stay or quit and search after privately observing an idiosyncratic shock to the firm. The market equilibrium endogenizes CEOs’ and firms’ outside options and captures contracting externalities. We show that the optimal pay‐to‐performance ratio is less than one even when the CEO is risk neutral. Moreover, the equilibrium pay‐to‐performance sensitivity depends positively on a firm’s idiosyncratic risk and negatively on the systematic risk. Our empirical tests using executive compensation data confirm these results.